Introduction to capital gains tax on divorce and separation

Capital Gains Tax (CGT) can arise on the sale or other disposal of an asset if the asset is sold (or, in some cases, has a market value) that is higher than the original cost of the asset, plus any enhancement expenditure and disposal costs. The current rates of CGT are 10%, to the extent that any income tax basic rate band is available, and then 20%. Higher rates of 18% and 28% apply for certain chargeable gains on residential properties with the exception of any element that qualifies for private residence relief.

If you are married or in a civil partnership, you can transfer assets from one to another without any CGT until you separate and after that event, the transfer between one spouse and the other is only free from CGT for transfers that occur on or before the earlier of (1) their divorce order or judicial separation and (2) the last day of the third tax year after the tax year in which they ceased to live together, i.e., before the 6 April in the third year from the year ending 5 April in which they separated.. 

However, once the assets are the subject of a formal separation agreement or divorce order you have an unlimited time in which to make a no gain/no loss transfer to your former partner. 

Capital gains tax divorce: separating and divorcing couples should, therefore, think carefully about and plan the split of their assets and take legal and tax advice to minimise the tax cost of their separation and leave as much value as possible to share between them

What is the definition of separation from my spouse/civil partner for CGT purposes?

Spouses or civil partners will be treated as separate for GCT when:

• They are separated under an order of a Court,
• Or they are separated by a formal Deed of Separation executed under seal (except in Scotland, where the deed should be witnessed),
• Or they are separated in such circumstances that the separation is likely permanent.

The marriage or civil partnership should have broken down. If the marriage or civil partnership has not broken down, but the couple does not reside in the same house, they are still treated as living together for CGT purposes.

Do you pay CGT on divorce settlements?

A property can be transferred from one spouse to another free of any capital gains tax if they are not separated. If they have separated, then the capital gains tax exemption is available only until the end of the third tax year after the tax year in which they separated (or if earlier, the date of their divorce or separation order). However, once the assets are the subject of a formal separation agreement or divorce order the couple have an unlimited time in which to make a no gain/no loss transfer to the former partner. 

For the purpose of the capital gains tax exemption for married couples, they are treated as separated from each other if the separation is under a court order, a separation agreement or they are separated in such circumstances that the separation is likely to be permanent. Once the capital gains tax exemption for married couples is no longer available, transfers between the separated couple will be treated as made between connected persons until the decree is absolute and may, therefore, be deemed to take place at market value, which may give rise to a liability to capital gains tax on the spouse disposing of the property, or a share in it (subject to any available exemptions such as main residence relief).

Transfers between the couple after the decree absolute will be on a no gain/no loss basis where the assets are taxed according to the actual sale proceeds received unless there is an element of undervaluing or an outright gift, in which case they will be treated for CGT, as made at market value and any gain taxed accordingly. Capital gains tax on a marital home in divorce should, therefore, be considered carefully.

How is divorce affected by Capital Gains Tax?

If you are separated, you can transfer assets between you free of CGT until the end of the third tax year after the tax year in which you separated, i.e., on or before 5 April of the third tax year (or if earlier, the date of your divorce or separation order).

Transfers between you after the third tax year from the tax year of separation will remain free of CGT if the assets are the subject of a formal separation agreement or divorce order but may otherwise be treated as gifts and, therefore liable to CGT if the market value is greater than the allowable base and other costs of the asset. Principal private residence relief may be available, however, if the asset is, or was the matrimonial home.

When is CGT paid on a separation or divorce?

CGT can be payable if the transfer of a matrimonial asset is to a third party or if it is transferred to the other spouse after the third tax year following the tax year in which the couple separates (or if earlier, the date of the divorce or separation order). If the asset is the matrimonial home, then the transfer may be exempt from CGT. 

If a chargeable gain arises on residential property and is not exempt, then for disposals on or after 27 October 2021, you need to report and pay the tax within 60 days of the disposal. For disposals of other property, the gain must be reported by 31 December in the year following the tax year in which the disposal occurred. Capital gains tax selling a house during divorce should, therefore, be considered carefully.

What if I am not a UK resident?

If you’re not resident in the UK you must report sales of UK property as a non-resident, even if you have no tax to pay.

What if the matrimonial home is sold?

If one spouse remains in a jointly owned home and the other moves out and later on the home is sold, the share of the sale proceeds belonging to the spouse who stayed will remain free of CGT as it was their main home.

Any capital gain on the other spouse’s share may be liable to CGT, but if the home is sold within 9 months of them moving out, then the exemption from CGT for their main residence will apply to the period of absence, but after that, a proportion of the spouse’s gain may be liable to CGT. 

Can CGT be deferred on a divorce or separation?

However, relief is available where, in connection with a separation or divorce or dissolution of civil partnership, the leaving spouse or civil partner disposes of their share of the jointly owned property to someone other than the remaining spouse or civil partner. 

This relief is only available if the leaving spouse makes the transfer more than 9 months after leaving the property and:

(a) it continues to be the other spouse’s only or main residence;

(b) the transfer takes place under a separation agreement or a consent order, and a claim is submitted to HMRC within 2 years; and

(c) the leaving spouse has not elected a new “principal private residence” since leaving.

If these conditions are met, the leaving spouse or civil partner will still obtain private residence relief from CGT for the period from his or her moving out to the point of transfer. In some cases, it may be more advantageous for the leaving spouse not to make a claim for this relief but to claim main residence relief on their new dwelling.

Relief is also available where the leaving spouse transfers their share of the jointly owned matrimonial property to the remaining spouse, and that “initial disposal” is in accordance with a deferred sale agreement. When the remaining spouse eventually sells the property and pays the leaving spouse their share of the profit on the sale, that payment is treated as a gain attributable to the initial disposal but accruing when received.

This means that eventual receipt of the share of profit by the leaving spouse qualifies for CGT private residence relief in the same proportion that that relief applied to the original disposal by the leaving spouse to the former spouse; or, where the original disposal qualified for no gain/no loss treatment, in the same proportion that private residence relief would have applied but for the no gain/no loss treatment.

What is a ‘no gain, no loss’ treatment?

No gain/no loss disposals are disposals where the asset is treated as passing from the transferor to the transferee at a value which results in neither a gain nor a loss accruing to the transferor.

For example, transfers between spouses or civil partners while they are living together will be treated as taking place on a no gain/no loss basis, and so the transferee will inherit the transferor’s CGT base cost of the asset.

Conclusion

Jodi Tuson Stater Heelis Solicitors concludes;

Divorce has the potential to be amongst the most stressful life events a person might experience. Although some financial concerns (such as ensuring your immediate housing needs are met) will be at the forefront of your mind, the tax implications of any potential settlement or final court order are not always considered in as much detail as they should be – in some cases, they are regrettably not even considered at all.

Often, the tax with the most significant implications in divorce will be capital gains tax. However, there are all manner of potential tax implications (including the treatment of dividend income from family companies and trusts) which may result in unexpected consequences. Accordingly, it is absolutely vital to seek expert tax advice in any situation relating to the financial consequences of divorce, including during the preparation of any pre- or post-nuptial agreement.

If you or your clients are facing a divorce or separation contact Patrick Cannon to ensure that the CGT and stamp duty exemptions on divorce, separation or dissolution of a civil partnership are fully taken into account, and any relief is claimed. SDLT on divorce and the transfer of assets is explained here.

Last Updated: 24 November 2023 to include the changes in section 41 Finance (No 2) Act 2023 to sections 58 and 225B, and insertion of section 225BA into, TCGA 1992.